Leveraged finance explained for undergrads

What does a leveraged finance group do?

When a private equity firm buys a company, most of the price is paid with borrowed money. Leveraged finance bankers structure that debt: how much, what kind, what interest rate, what covenants. The bank often commits to provide the financing so the buyer can sign the deal, then sells the debt to investors such as loan funds, high-yield funds, and private credit lenders.

Leveraged finance also refinances existing debt, funds acquisitions by companies that are already leveraged, and pays dividends to sponsors from new borrowing. The common thread is a borrower riskier than the blue-chip companies that borrow in investment grade markets.

• Leveraged loans: floating rate, usually senior secured, sold to loan investors.
• High-yield bonds: fixed rate, often unsecured or junior, sold to bond investors.
• Revolvers: credit lines the company can draw on, usually kept by banks.
• Bridge commitments: a promise to lend if the bonds cannot be sold in time for closing.

What numbers does a leveraged finance analyst live in?

Everything starts with EBITDA, a rough measure of operating cash flow. Lenders ask how many turns of EBITDA the company can borrow and whether the cash flow covers the interest. Here is a simplified hypothetical: a company makes 100 of EBITDA and will borrow 500. Leverage is 500 / 100 = 5.0x. If the blended interest rate is 9%, annual interest is 45, so interest coverage is 100 / 45, or about 2.2x.

Then you stress it. If EBITDA falls 20% to 80, leverage rises to 6.25x and coverage falls to about 1.8x. The analyst's job is to show investors and the bank's own credit committee how the company does in the bad case, not just the base case.

• Total leverage: total debt divided by EBITDA.
• Senior secured leverage: secured debt only, divided by EBITDA.
• Interest coverage: EBITDA divided by interest expense.
• Free cash flow to debt: how fast the company can pay the debt down.
• Ratings: the agencies' view, which drives which investors can buy.

How is leveraged finance different from M&A and DCM?

M&A advises on whether and how to buy or sell a company. Leveraged finance funds the purchase. DCM arranges debt for investment grade borrowers, where the questions are mostly about pricing and timing, while leveraged finance spends more time on credit risk because the borrower might not pay.

At many large banks leveraged finance works closely with the financial sponsors coverage group and with the trading desks that sell the debt, so analysts see both the deal side and the market side. Where it sits in the org chart varies: some banks put it inside capital markets, others run it as its own group.

Which banks run large leveraged finance businesses?

Leveraged finance needs a balance sheet, because the bank commits its own money before selling the debt. That makes it a business of the large lending banks. The banks below are among them; live status comes from each bank's own careers site. Most of them recruit summer analysts into the bank and place them in groups, so check how each program works.

• J.P. MorganWatching
• Goldman SachsOpen1 open now
• Bank of AmericaOpen, some offices1 open now
• CitiOpen1 open now
• BarclaysExpectedExpected early December

Who is leveraged finance a good fit for?

It suits people who want deal experience and markets exposure at once, and who like thinking about downside. The exits are strong into private equity, because you will have seen many buyouts from the financing side, and into private credit and leveraged loan funds, which do the lending you helped structure.

• Good fit: you liked the LBO when you learned it, you think about what could go wrong, you want to see the market react to your deals.
• Harder fit: you want strategic advisory work on what a company should do, rather than how it pays for it.

How do you prepare for leveraged finance as a sophomore?

The technical core is the same as any IB interview, plus credit. If you can explain an LBO and the ratios above, you can hold a real conversation with a leveraged finance banker.

1. Learn how an LBO works and why debt raises the equity return.
2. Memorize the four ratios above and practice them on a simple example.
3. Read about one recent sponsor buyout in the financial press and note how it was financed.
4. On calls with leveraged finance bankers, ask how their group splits work with sponsors coverage and with the desk.

Questions students ask

What does below investment grade mean?

A credit rating below BBB- from S&P or Fitch, or Baa3 from Moody's. Those borrowers pay higher rates and are sold to a different set of investors.

Is leveraged finance a good path to private equity?

Yes, it is one of the more direct ones, because you see the financing of buyouts up close and learn how sponsors think about debt.

Is leveraged finance the same as private credit?

No. Leveraged finance at a bank arranges debt and sells it to investors. Private credit funds lend their own money directly and hold the loan.

Do leveraged finance analysts build LBO models?

They build credit-focused models: debt capacity, interest, repayment, and stress cases. A full LBO with equity returns is more of a sponsor's or M&A team's model, though the pieces overlap.